How Is A Credit Score Calculated?
There are many financial concepts that are daunting to learn about. Credit scores are not one of them. While the Fair Isaac Corporation behind your credit score (a.k.a. FICO score) does not reveal the precise formula for calculating it, the main categories are well-known. Here is how they break down by level of importance.
Payment History – 35% of your score
The main concern here: Do you meet your financial obligations? Lenders need to know that you can make payments on time. If you can’t, you are too much of a risky investment. If you have past issues like bankruptcy or delinquency, that will hurt your credit score. Even more so if the issues were left unresolved for a long time. But there is hope. You can improve your score simply by staying on top of your due dates.
Debt Level – 30% of your score
Lenders also want to know how much debt you currently have. The larger the debt, the lower the score. Having debt across several accounts is also harmful, as is using too much of your available credit each month. For example, it is not a good idea to use more than 30% of your credit card balance as it looks like you rely on that rather than your income. Paying back debts and keeping balances low should help your score bounce back.
Length of Credit History – 15% of your score
A long credit history can boost your score, too. That gives lenders plenty of evidence that you are a responsible borrower. Keep in mind that your credit report relies on the average age of your accounts, rather than the age of your oldest account. If you open too many new accounts at once, it can lower your score. This is also why it is wise to keep old accounts open, if possible.
New Credit – 10% of your score
The more applications you submit for credit and loans, the more inquiries about your credit history are generated. With each new inquiry, your score can drop. Applying for a lot of credit at once makes it look like you are under excessive financial burdens, which makes is worrisome to lenders. It is best to wait a few months between applications instead.
Type of Credit – 10% of your score
Have the basics covered – housing, credit cards, car loans, etc. – but do not go far beyond that. Your credit score can get dinged if you have more than a couple credit cards, for instance. You do not want greater potential for debt than you can handle. Nor do you want a ton of bills to track. It is best to focus on managing a small variety of accounts.